What Does a Fed Rate Hike Really Mean for Commercial Real Estate? 10 Top Economists Weigh In
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There are growing expectations that the Fed will raise interest rates by the end of this year and, some predict, as early as September. Bisnow polled 10 of the country's top economists to find out what a Fed rate hike really means for commercial real estate.
Victor Calanog, Chief Economist, Reis
"There are really two parts to this question: first, what does the impending rate hike mean for commercial real estate prices in the short run; second, what do higher interest rates imply for commercial real estate in the long run? The second question is easy to handle: in the long run, a higher interest rate environment means higher cap rates, and therefore, lower valuations, for commercial real estate properties. In the short run, however, a nominal increase in interest rates will probably do little to move the needle on commercial real estate pricing. Spreads are still wide so any upward pressure on cap rates will be nil; if anything, if the market perceives the rate hike to be a sign of strength for the US economy, foreign capital and heightened activity in real assets might mean lower cap rates and higher prices for the most desirable of properties in prime locations."
Rajeev Dhawan, Director of Economic Forecasting Center at J. Mack Robinson College of Business, Georgia State University
"First, we need to examine the reasons that lead to the Fed raising its rate, namely inflation and growth prospects for the future. Higher inflation tomorrow means that contracts that allow for inflation clauses will bump up the cash-flow stream from a property. That can negate the hit from the higher discount rate from the future higher interest rates. But most importantly, what causes inflation in a developed economy with an independent central bank? Accelerating job growth, which means more demand for transportation, office and industrial space. Maybe not the near-perfect one-to-one correlation as it was in the 1980s and 1990s, but still a strong positive. This means that rental growth is likely higher in the future (keep fingers crossed on an overbuilding or construction bubble that mercifully doesn’t exist at present) leading to an increase in property values. The big 'if' here is that the Fed does not make a mistake when raising rates, i.e. is premature or too aggressive in its rate hikes. This is more important as the economy’s potential now is not as robust as it was in the late 1990s."
Ray Torto, Harvard Lecturer and Former Global Chief Economist, CBRE
"The Fed hike will be at the short end of the curve and usually this leads to increases in the long end. In today’s world, the excess supply of capital will push back against the traditional scenario, and I expect to see the yield curve flatten. For long-term commercial real estate investors, I expect to see little effect on cap rates, but I also expect to see some downward compression on returns, whether leveraged or not. However, this latter effect is universal across all asset classes. The advantage for commercial real estate investments at this stage of the cycle is that commercial real estate assets, where NOI can/will grow strongly, will continue to do well. Asset selection will be an important key to success in commercial real estate."
Kevin Thorpe, Chief Economist - Americas, DTZ
"Our industry needs to keep in mind that the Federal Reserve does not control long-term interest rates. That is a common misconception. So a 25 bps hike in September, if that is indeed what we get, doesn’t necessarily mean anything for long-term interest rates or values. Inflation expectations are the key metric to watch to gauge movements in interest rates. And right now, there is very little inflation in the world economy. That is a force that will keep the 10-year yield low at least for one more year, in all probability. If long-term rates do rise gradually, it is important to understand why they are rising. If it’s a function of a strengthening economy, which is the most likely scenario, then all the fundamentals that drive real estate values will be improving—meaning lower vacancy, higher rents, greater risk appetite for real estate—all of that will drive values up for most product types. If rates are rising because the US is suddenly perceived as a riskier investment relative to the rest of the globe, then sell immediately."
Jamie Woodwell, VP for Commercial Real Estate Research, Mortgage Bankers Association
“The Fed’s rate hike will be at the short end of the yield curve, and could start to nudge up adjustable and short-term rates. But by now longer-term rates have largely baked in the increase. We’re likely to see a flattening of the yield curve, which could bring a change in the types of financing borrowers choose, but overall a rate hike isn’t likely to have much of an impact on commercial real estate pricing. Rather than focusing on the first hike, investors should probably heed the Governors’ advice and focus on the long-term slope and endpoint in their projections. That’ll give a better indication of capital flows and pricing—and the types of capital environments commercial real estate will be in over the next few years.”
Brad Case, SVP of Research & Industry Information, NAREIT
"A rate hike means the Fed has confidence that macro conditions will continue to improve—basically, that the economic recovery has become self-sustaining—and the economy doesn’t need any more boost from artificially low rates. Poorly managed properties may decline in value as a result of an increase in cap rates, but for well-managed properties higher occupancies, stronger rent growth and stronger NOI growth will outweigh any increase in cap rates, causing market values to increase. Well-managed balance sheets will also be stronger: if you’ve financed using variable rates or short maturities then your financing costs will increase, but if you’re holding fixed-rate debt with long maturities then the market value of your debts will actually decline. As usual, more challenging market conditions work to the advantage of good managers—they separate the wheat from the chaff in real estate investment management."
Jeffrey Havsy, Americas Chief Economist, CBRE
“Given the near record spread between cap rates and 10-year Treasuries, the impact of rate hikes will be less than most people expect. The first Fed move may cause a tick up in cap rates, but as interest rates rise, cap rates will move at a much slower pace. The spread between cap rates and interest rates will compress at a faster rate than the rise in cap rates.”
Andrew Nelson, US Chief Economist, Colliers International
"The first one? Little to none, especially if, as expected, this first hike is modest, say 25 to 50 bps. Current pricing largely reflects this expectation, in both property and equity markets. Successive hikes should have greater impacts—eventually. The spread between cap rates and the 10-year US Treasury are still above their long-term averages in most markets, which will act as a cushion for the initial interest rate hikes: cap rates won’t increase nearly as much or as fast as interest rates. Moreover, investor interest in US property is strong and should remain so as long as bond rates are relatively low, which will limit price hits for the initial rate hikes. But not forever ..."
Mark Dotzour, Chief Economist, Real Estate Center, Texas A&M University
"I think it's very possible that the 10-year Treasury has already 'baked in the cake' the anticipated increases in the Fed Funds rate. The expected rate of inflation is still really low. No reason for the 10-year to increase much, regardless of what the Fed says or does."
Robert Bach, Director of Research - Americas, Newmark Grubb Knight Frank
"The Fed’s first rate hike won’t mean much. It’s likely to be just a quarter of a point, and it’s arguably the most widely telegraphed, most widely dissected rate hike since the Fed began targeting the federal funds rate in the 1980s. The speed of subsequent rate hikes could affect pricing, but the leasing and capital markets both have such momentum now that it would take a lot to derail the market. The still sluggish rate of inflation argues for a slow and measured series of interest rate hikes. A faster series of rate hikes would imply rising inflation, which isn’t necessarily bad for commercial real estate because a higher CPI translates into bigger rent bumps, higher construction costs and higher replacement costs—all favorable trends for CRE."